Why the Diageo share price looks like a once-in-a-decade passive income opportunity

The Diageo share price has fallen 14% as the FTSE 100 hits new highs. At its lowest price-to-sales ratio for a decade, is the stock too cheap to ignore?

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Diageo (LSE:DGE) has increased its dividend annually for the last 37 years, but its share price is down 14% over the last 12 months. Sales might be down, but the stock’s down more.

As a result, Diageo shares trade at their lowest price-to-sales (P/S) ratio for 10 years. This looks like a stock market overreaction – and an unusually good potential opportunity.

Declining revenues

At its latest update, Diageo reported a 1.4% decline in revenues during the second half of 2023. The weakest region was Latin America and the Caribbean (LAC), where sales fell 23%.

Management attributed this to a number of factors. These included unusually high sales in the previous year, consumers trading down, and a weak macroeconomic environment.

Excluding these – as the company pointed out – Diageo would have achieved revenue growth of 0.7%. But while I understand the justification for exclusion, I’m not convinced by it.

Fortunately, the case for thinking the stock is a once-in-a-decade opportunity doesn’t depend on ignoring the revenue decline. Even with this, the stock looks unusually cheap.

Price-to-sales

Diageo’s share price has been falling faster than the company’s sales. As a result, its P/S ratio has fallen from 4.95 a year ago to 3.76 today – its lowest level for a decade. 

Diageo P/S ratio 2014-24


Created at TradingView

Looking at Diageo’s P/S ratio is an unusual choice – its price-to-earnings (P/E) ratio offers a much better idea of the likely returns from the stock. But there’s a reason for this.

Over the last few years, inflation’s been at some of its highest levels for decades. This has been creating unusual pressure on margins, but it’s already starting to subside. 

That’s why I think sales (which aren’t affected by margin fluctuations) offer a better contrast than earnings (which are). By this metric, Diageo’s stock’s at its lowest price in a decade.

Risks

There’s a risk the company’s struggles in LAC might spread elsewhere. Switching costs are non-existent, so there’s a constant danger of consumers trading down. 

Moreover, several other consumer products firms have been reporting weak sales in the US, which accounts for 37% of Diageo’s revenues. So the threat of sales declining further is real.

This however is where investors with a long-term outlook have a big advantage. Diageo’s biggest asset is its brands, which include leading products in a number of categories.

In terms of revenues, things might get worse before they get better. But, over time, I expect the company’s brand strength to drive consistent growth in both sales and profits.

Passive income

It’s easy to see what makes Diageo a quality business, which is why the stock rarely trades at a bargain price. But sooner or later even the best stocks present buying opportunities.

Investing well involves two things. The first is being patient enough to wait for the right opportunities, and the second is being ready to seize them when they come. 

Diageo has a terrific record when it comes to dividends. And I think investors could benefit from decades of passive income. I feel it’s worth doing further research into the stock.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright owns shares in Diageo Plc. The Motley Fool UK has recommended Diageo Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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